In the news: Satyam

Business Week reports on Satyam Scandal (link: India's Madoff? Satyam Scandal Rocks Outsourcing Industry.

What happened here? It appears to be primarily a governance and accounting scandal although, as the article notes, there have been recent warning signs on the operation front.

But, as the article asks, will this tar the whole Indian sector? I doubt it. There will be two, somewhat offsetting effects.

1. Customers will come to realize that they are taking country and governance risk when they go offshore. This risk has always been there, it’s just that many customers ignored it. This will lead to a slowdown in new contract announcements in the next quarter or two. But then the announcements will pick up again and the Satyam scandal will seem like a minor blip. A good analogy would be the nuclear tests that India and Pakistan made in May 1998. This shook everyone for a few months, then the contracts started flowing again—but with a renewed emphasis on geographic diversification and seamless disaster recovery capability.
2. What are the competitive effects? As of today, Satyam is making a big deal that only one customer has left. But this will not last. My friends in the industry tell me that all of Satyam’s large customers are looking around. Some activities can be shifted to new suppliers quickly (call centers, standard platform financial systems). Others take more time (claims processing, custom systems, application development). Expect a torrent of defections to unfold over the next 3-12 months.

What next? Beyond the effects described above, I expect two major outcomes.

1. Expect a rush to strongly branded global firms (IBM, Accenture, TCS, Wipro, INFY, etc.) and away from the mid-tier suppliers. The economics of offshoring are too compelling to bring the work back home. But customers also want to feel comfortable. Like the 1960s saying “no one every got fired for buying IBM.”
2. Expect to see a rush of offshoring firm announcing listings in the US and EU. It’s a simple way for a developing country firm to “import” the US/EU regulatory framework. To be listed (in the US), a firm must issue GAAP financial statements, meet Sarbox requirements, and adhere to the Foreign Corrupt Practices Act. None of these regs are a guarantee, but they are a very visible 9and expensive) signal of quality.

What do you think? Am I too optimistic? Will multinationals really pull back because of the scandal?